Avoiding ERC Scams, Part I: The Basics

When Congress passed the CARES Act in March 2020, they authorized the Payroll Protection Program (PPP) and the Employee Retention Credit (ERC). At the time, a business could avail themselves of either the PPP or the ERC, but not both. Predictably, business owners took out forgivable PPP loans.

In December 2020, Congress amended the CARES Act. One of the key changes in the amendment allowed taxpayers to simultaneously take out a PPP loan and apply for the ERC. Since Congress expanded ERC eligibility, a large number of unscrupulous firms (or “scammers,” as the IRS calls them) have attempted to lure unsuspecting business owners into believing that they qualify for the ERC when they do not. The prevalence of these firms and the ERC scams they promote prompted the IRS to issue at least three warnings.

Our goal is to help you defend your business against the ERC con-artists. First, we familiarize you with the IRS’ warnings and explain the inherent complexity of the ERC. After this, we provide a guide to understand Weaver’s legitimate and thorough process to determine if a business qualifies for the ERC.

The IRS Goes on the Offensive: Warnings Against Scammers

The IRS’ public warnings started in late 2022. In IR-2022-183, they “warned employers to be wary of third parties who are advising them to claim the ERC when they may not qualify. Some third parties are taking improper positions related to taxpayer eligibility for and computation of the credit. These third parties often charge large upfront fees or a fee that is contingent on the amount of the refund and may not inform taxpayers that wage deductions claimed on the business’ federal income tax return must be reduced by the amount of the credit.” 

They urged businesses to be cautious of “advertised schemes and direct solicitations promising tax savings that are too good to be true. Taxpayers are always responsible for the information reported on their tax returns. Improperly claiming the ERC could result in taxpayers being required to repay the credit along with penalties and interest.”

The warnings continued when ERC scams landed at the top of the IRS 2023 “Dirty Dozen Tax Scams.” The IRS did not mince words and classified “aggressive pitches from scammers who promote large refunds related to the ERC” as “a blatant attempt by promoters to con ineligible people to claim the credit.” The IRS highlighted the schemes from promoters who blasted radio and digital ads touting refunds involving Employee Retention Credits.

In their latest warning, IR-2023-15, the agency detailed warning signs of aggressive ERC marketing and explained how promoters lure victims. The IRS lists the following warning signs:

• Unsolicited calls or advertisements mentioning an “easy application process”
• Statements that the scammer can determine ERC eligibility “within minutes”
• Large upfront fees to claim the credit
• Contingency fees based on a percentage of the refund amount of ERC claimed
• Aggressive claims that the business qualifies before any discussion of the business’ tax situation. As we discuss below, the ERC is a complex credit that requires careful review and detailed analysis before applying.
• Aggressive suggestions from marketers urging businesses to submit the claim because there is nothing to lose. In reality, those improperly receiving the credit could have to repay the credit – along with substantial interest and penalties.

We have seen these tactics used against some of our clients. We have also seen the scammers send an ERC “refund notice.” The notice is deceptively designed so it resembles a notice from the IRS. In one instance, the scammer told a client that they calculated an ERC refund of over $400,000 for a particular quarter. Since this was about $100,000 more than the client’s quarterly payroll, the scammer fabricated the number out of thin air.

ERC Basics

To penetrate the fog of disinformation, let’s start with the rudiments of the ERC.

At its most basic level, the ERC is a tax refund of payroll taxes paid to eligible employees. Taxpayers claim the ERC by filing an amended payroll tax return (Form 941-X). For 2020 credits, the filing deadline is April 15, 2024. For 2021 credits, the filing deadline is April 15, 2025.

Amount of the Credit

For 2020, the credit can be up to $5,000 per employee for the entire year (50% of qualified wages up to $10,000). For 2021, the credit can be up to $7,000 per eligible employee per qualifying quarter (70% of qualified wages up to $10,000 for a potential ERC of $21,000 per eligible employee across three quarters).

The scammers typically start their con job by falsely creating the impression that a business can automatically get a $26,000 credit for every employee. As we explain below, given the statutory limitations and operations of the ERC, in many cases it is not possible to get a $26,000 credit per employee.

Determining if You Qualify: It Ain’t Simple

The Cares Act mandates two criteria for ERC qualification:

• experience a significant business impact from COVID and
• meet the full-time equivalent (FTE) requirement

To demonstrate a significant business impact from COVID, an employer can qualify by:

• experiencing a significant decline in gross receipts or
• experiencing a partial or full-shut-down

Gross receipts are statutorily defined in the CARES Act (by reference to Internal Revenue Code (IRC) section 448(m)) as revenue less returns and allowances, dividends, interest and certain gains and losses on the sale of investments. For non-profit organizations, gross receipts are defined with reference to IRC section 6033.

A significant decline in gross receipts is defined as follows:

• For 2020, there must be at least one quarter where gross receipts declined more than 50% when compared to the same quarter of 2019.
• For 2021, there must be at least one quarter where gross receipts declined more than 20% when compared to the same quarter of 2019.
• Also for 2021, the Alternate Quarter Election (AQE) can be used for a calendar quarter by comparing gross receipts for the immediately preceding calendar quarter with those for the corresponding calendar quarter in 2019. For example, a business whose gross receipts declined 15% in Q1-21 but 30% in Q4-20 could use the AQE to claim eligibility for Q1-21.
• There are special rules for so-called recovery start-up businesses.

If a business fails to meet the gross receipts test, then it may be eligible for the ERC under the full or partial shutdown rule. This is relatively complicated rule and subject to much abuse by scammers. Therefore, we discuss it in a separate post.

FTE Requirement

FTEs (full time equivalents) are different than headcount (the raw number of employees) because they measure the number of employees (full and fractional) based on the number of hours worked in a specified time period. The number of FTEs is determined based on 2019 employment data. Note that the IRS method for calculating FTEs for the ERC is not the same as the method that was used by the SBA to calculate FTEs and determine the headcount reduction ratio for PPP loan forgiveness.

• To be ERC-eligible in 2020, an employer can have no more than 100 FTEs
• To be ERC-eligible in 2021, an employer can have no more than 500 FTEs

There is an exception to this: employers who exceed the FTE threshold can be eligible for the ERC but only for wages paid while their employees were not working.

You Can’t “Keep It Simple, Stupid”: What Scammers Don’t Tell You

Because they want to earn a quick buck and get you hooked (and themselves paid) ASAP, scammers usually leave out other key details of the ERC program. This oversimplifies the ERC process, leaves an employer with a false sense of security and may cause an employer to file an erroneous 941-X.

The following items must be considered when determining ERC eligibility and calculating the amount of the credit.

• Test for controlled group membership
• The CARES Act and the IRS’ ERC guidance mandate that for a controlled group (entities under common control [defined in IRC sections 52(a) and (b), 414(m) and 414(o)], gross receipts and FTEs have to be aggregated to conduct the revenue and FTE tests discussed above. This can work both for and against the taxpayer.
• In practice, we’ve seen instances where one entity in a controlled group qualified on a stand-alone basis but not on a combined basis. We’ve also seen the opposite occur, where revenue declines in one exceptionally large entity swamped the revenue increases of smaller members of the controlled group.
• A final point: control group determinations for entities owned in whole or part by a private equity group (PEG) or a large home office are especially complicated. In our experience, these businesses often fail to qualify for the ERC when aggregated with other businesses owned by the PEG or home office.
• Exclude PPP wages
• Wages used for PPP loan forgiveness cannot be used to claim the ERC. So if you took out a PPP loan and also qualify for the ERC, you have to coordinate between the two programs to maximize the ERC.
• Specifically, this involves considering and ultimately modeling out the 60%/40% split between payroll and qualified non-payroll expenses; where eligible wages fall relative to the PPP covered period and the ERC-eligible quarters; the PPP salary cap (which is different for so-called Table 1 and Table 2 employees) versus the ERC quarterly or annual salary cap, and the (greater than 5%) owners’ compensation cap.
• Note that the IRS’ related party rules add a layer of complexity to these calculations, since related-party wages that were allowed for PPP purposes could be disallowed for ERC purposes.
• Exclude related party wages
• The wages of persons who are related parties, according to the IRS definitions, are ineligible for the ERC. To determine if an employee is a related party requires navigating the implications of multiple sections of the tax code (IRC sections 51(i)(1), 152(d)(2) and 267(c)).
• Along with not having the maximum amount of salary, the exclusion of PPP and related-party wages are the key reasons why, in hundreds of ERC engagements, we have yet to see a client receive a $26,000 ERC per employee.
• Amend your business’ tax return
• If your business claims the ERC, it must file an amended tax return for the year or years to which the ERC relates. Per IRS Notice 2021-20 (Q/A 60), “Section 280C(a) generally disallows a deduction for the portion of wages or salaries paid or incurred equal to the sum of certain credits determined for the taxable year.” As we discuss in Part II of this blog, this prevents a taxpayer from double-dipping (receiving a double tax benefit).
• Whenever we have a discussion with an ERC prospect, we inform them of these crucial details. In contrast, the IRS points out that the scammers often leave them out (this is consistent with solicitations received by our clients). Ask yourself why that is.

Next Steps

If you would like an honest and impartial assessment as to whether your business qualified for the ERC, please contact us.

©2023

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This is one in a series of related employee retention credit posts:

• Avoiding ERC Scams Part II: The Partial Shut-Down Safe Harbor
• Avoiding ERC Scams, Part III: The “More Than Nominal” Test